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By Rob Wherry
Wall Street Journal. (Eastern edition). New York, N.Y.: May 7, 2007. pg. R.1
Compass Minerals International Inc. is one of the largest salt producers in the world, last year selling 10.5 million tons that eventually were sprinkled on French fries and popcorn or laid atop ice-coated highways. The Overland Park, Kan., firm has increased its earnings per share 40% since going public in 2003.
But Laton Spahr, one of the managers of RiverSource Dividend Opportunity Fund, has purchased 447,330 shares of the company since 2004 for his portfolio for a more-important reason: a 3.6% dividend yield, double that of the broader market.
Investors, in turn, are flocking to funds such as RiverSource that focus on dividend-paying stocks. Part of the attraction is top-notch performance: The $1.9 billion RiverSource fund, for instance, has beaten the Standard & Poor's 500-stock index by an average of about six percentage points annually over the past three years. In addition, there is the 2003 Jobs and Growth Tax Relief Reconciliation Act, which reduced the maximum federal tax rate on qualified dividends to 15% from as much as 38.6%, until sometime in 2010.
But also fueling the comeback is a change in attitude about dividends, not only on Main Street but in the boardroom, too.
During the late 1990s, many individual investors were consumed with the capital appreciation of technology stocks that soared to record prices. After the bubble burst and a bear market took hold, many baby boomers facing retirement got spooked when their savings plummeted in value. They sought out investments that could provide extra income and weather stormy markets, leading them to rediscover the power of dividends.
Recent data indicate it was a smart shift. According to a Morgan Stanley report, stocks that paid dividends returned an average annual 10.2% from 1970 through 2005, almost six percentage points ahead of nonpayers. And dividend-paying stocks provide some protection in a down market, says John Gould, co-manager of Cullen High Dividend Equity Fund, an important attribute given the possibility that the market soon might slip after nearly five years of gains.
The tech-stock bubble "was one of those things -- like so many in investing -- where people were just looking at the short term," says John Merrill, who helps manage $525 million for Tanglewood Capital Management Inc. in Houston. "But, the further you look out, the more important dividends become."
The average payout ratio -- the percentage of earnings paid to shareholders in dividends -- fell earlier this decade to 29%, one of the lowest rates in the past 80 years. By 2003, though, companies flush with cash and attracted to the new tax legislation paid dividends in addition to, or in place of, share-buyback programs or acquisitions. Even some in the technology industry -- a sector not known for dividend payments -- jumped on board, including Microsoft Corp.
According to Standard & Poor's Corp., 383 companies in the S&P 500 paid dividends last year, compared with 351 in 2001. (A decade ago, 427 paid out.) The average payout ratio currently is just below 32%.
The dividend trend hasn't gone unnoticed by the mutual-fund industry. The number of equity-income funds -- a category known for favoring dividends -- has roughly doubled since the year before the tax bill was passed, according to market researcher Lipper Inc. Money under management in this group has jumped 150% to $166 billion.
There are also new dividend-focused exchange-traded funds, including 36 from upstart WisdomTree Investments Inc. Even index-fund stalwart Vanguard Group has a high-yield-dividend ETF. And in November, Eaton Vance Tax-Managed Diversified Equity Income raised $2.6 billion in what Eaton Vance Corp. said was the largest initial public offering of a closed-end fund at the time. (Unlike regular mutual funds, closed- end funds sell shares through IPOs; the shares then are listed on an exchange where they trade like stocks.)
While there is some debate as to whether large-capitalization dividend payers are poised to cede ground to "growth" stocks -- those of companies with earnings that are growing faster than the market average -- stock pickers such as David Geller, chief executive of GV Financial Advisors in Atlanta, say that, in general, "dividend stocks are a good idea."
There is a strong historical case for making one of these dividend offerings a core holding in a tax-advantaged account. Morgan Stanley estimates that 40% of the S&P 500's annual total returns came from dividends from 1926 through 2004.
The only question left for many investors is which fund is the best fit.
Equity-Income Funds
The simplest way to get exposure to dividends long has been to invest in an equity-income fund offered by firms such as American Century Investments, Fidelity Investments, Principal Financial Group Inc. and Vanguard. The category returned 16.3% over the 12 months through April 30, according to Lipper, tops of any broad U.S. stock group.
American Century Equity Income is a multicap fund that seeks stocks trading in the cheapest half of the Russell 3000 based on debt- adjusted cash-flow valuations. Lead manager Phillip Davidson also keeps an eye on metrics like price-to-earnings ratios and relative yield. The goal: a portfolio that yields two percentage points greater than that of the S&P 500. "It used to be that you would be embarrassed to say you owned a fund like this," he says. "It was considered ultraconservative." The fund has beaten the S&P 500 by four percentage points over the past 10 years.
Joe Suty, who in 2005 became manager of Principal Equity Income Fund -- formerly named WM Equity Income Fund -- likes large-company stocks that trade at a discount to peers based on financial ratios such as share price to book value, cash flow or earnings per share. One current favorite is Kraft Foods Inc. Mr. Suty likes the company's brands and thinks strong management can expand the business. Last month, Kraft shares were boasting a 3% dividend yield.
Growth Funds
Another group of longstanding dividend-focused funds seeks stocks that not only pay dividends but increase the level of payouts every quarter or year. These funds include RiverSource Dividend Opportunity and T. Rowe Price Dividend Growth.
Shortly after the 2003 tax bill was passed, RiverSource Investments converted its utility-only fund into the newly named Dividend Opportunity. This fund employs nine sector analysts and four managers to find stocks that will help the portfolio yield 50% more than the S&P 500. By favoring dividend growth, estimated by Bank of America analyst Thomas McManus at 10% this year for the broad market, Mr. Spahr and his colleagues think they have a good hedge against inflation.
The fund, in the top 4% of its Morningstar category over the past three years, has been helped by large stakes in energy firms like Chevron Corp. and BP PLC. Mr. Spahr also is finding candidates in parts of the market he never would have just a few years ago. Three years ago, for example, it would have been unheard of for a semiconductor company to pay a dividend, "but there has been a sea change around that idea," he says.
Exchange-Traded Funds
Many financial advisers are inspecting new offerings from the exchange-traded fund industry and from established firms entering this niche. ETFs are often likened to index-tracking mutual funds, with the most obvious difference being that they are traded on stock exchanges.
Morgan Stanley analyst Paul Mazzilli tracks seven high-yield ETFs from firms such as WisdomTree and PowerShares Capital Management, a unit of Amvescap PLC, that combined have more than $10 billion under management and recently ranged in yield from 1.4% to 3.8%. "Performance comparisons are not yet relevant as most of the underlying indices are relatively new," he recently wrote. Still, he thinks these ETFs could be an "attractive investment."
The Vanguard ETF, Vanguard Dividend Appreciation, screens for companies that are most likely to continue expanding dividends. WisdomTree has 36 domestic and international ETFs that weight companies based on their dividend yields. WisdomTree's broad Total Dividend Fund tracks 1,500 companies, while narrower-focused funds focus on small, midsize or large payers.
PowerShares offers four funds focused on companies that have increased their payouts every year for the past 10 years. Its High Yield Equity Dividend Achievers Portfolio has garnered $450 million since 2004. "The tax treatment definitely helped," says Bruce Bond, Powershares' founder. "It got people to focus on dividends again."
'Dividend Capture'
Eaton Vance was one of the first companies out of the gate when Capitol Hill reduced the tax rate on dividends, launching Tax-Managed Dividend Income Fund just two months after the bill was signed.
Since then the Boston company has brought to market 10 others aimed at deriving income from stocks. It typically buys stocks trading on the cheap with expanding dividends and strong franchises, like a utility that has a lock on transmission lines in a certain region.
At times, the fund managers also employ a strategy called "dividend capture." This entails buying a stock when a special or regular dividend is announced and holding it for 61 days to qualify for the attractive tax rates.
Judy Saryan, an Eaton Vance vice president and portfolio manager, thinks the dividend theme is here to stay. She anticipates that payout ratios eventually will rise to the historic average of about 50%. "A share buyback is all well and good, but sometimes they are announced and never done," she says. "Initiating a dividend is a good way of attracting long-term investors."
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Mr. Wherry is a senior writer for SmartMoney.com in New York. He can be reached at rwherry@smartmoney.com (Related) .
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